USCI - COMT: The Right Optimized Commodity ETF For Strong Energy Markets

2023-10-18 14:57:11 ET

Summary

• The United States Commodity Index Fund is our preferred commodity ETF, followed by the iShares GSCI Commodity Dynamic Roll Strategy ETF.
• COMT is an optimized commodity ETF that maximizes roll yields by selecting commodities and futures contracts with strong backwardation or mild contango.
• COMT has outperformed GSG and USCI since its inception, with lower volatility and a similar commodity exposure as GSG.
• The current environment, with Energy being the only commodity sector in a long term uptrend, also favors an investment in the more energy-heavy COMT.

Our favorite commodity ETFs are the United States Commodity Index Fund ( USCI ) and to a lesser extent the iShares S&P GSCI Commodity-Indexed Trust ETF ( GSG ).

Another second generation commodity ETF, besides USCI, that could be interesting is the iShares GSCI Commodity Dynamic Roll Strategy ETF ( COMT ). COMT is a so-called optimized commodity ETF that tries to maximize (roll) yields by systematically choosing commodities and futures contracts with the strongest backwardation or the mildest contango.

As previously explained :

Famous commodity indices like the S&P GSCI Index and the Bloomberg Commodity Index use a basic strategy: the so-called front-month roll. In this case investors receive the closest exposure they can get to the spot price of a commodity, as the front-month and spot prices tend to move closely together. A possible drawback of this strategy is the negative roll yield when the market is in contango.

To circumvent this problem so-called optimized strategies were developed. Such strategies try to maximize (roll) yields by systematically choosing commodities and futures contracts with the strongest backwardation or the mildest contango.

COMT has the same commodity exposure as GSG, but it has the possibility to steer away from the front month futures contracts if this would lead to higher roll yields. This implies that COMT is as energy-heavy as GSG. This is an advantage now that energy markets are performing well.

Since its inception at the end of 2014 COMT clearly outperformed GSG and even marginally outperformed USCI.

And importantly it achieved this result with a lower volatility than GSG. The more diversified USCI had still lower volatility.

Oil market crashes are normally accompanied by a shift from backwardation to contango. This was the case in 2015 when Saudi Arabia tried to push US shale producers out of business and in 2020 during the Covid crisis.

When a futures curve is in contango holding a position further along the futures curve at a point where the curve is less steep (the yellow area in Figure 4), the negative roll yield is less pronounced each time the position is rolled.

ETFs like GSG that use the front-month roll (the blue area in Figure 4) incur heavier negative roll yields.

For more info about contango and backwardation we refer you to this previous article .

Optimized ETFs like COMT and USCI enjoy a positive roll yield when the commodity markets are in backwardation. When markets are in contango their roll yield is better than the one experienced by a traditional front month rolling index or ETF.

On top of that they are less volatile than a traditional ETF because front month futures contracts are more volatile.

If we compare the S&P GSCI Dynamic Roll index with the S&P GSCI (remember that the two indices have the same commodity exposure) the former is clearly less volatile on a 1, 3 and 5 year horizon.

iShares GSCI Commodity Dynamic Roll Strategy ETF

COMT is linked to the S&P GSCI Dynamic Roll Index. This index measures the performance of the same underlying commodities as the S&P GSCI and is hence also energy-heavy.

The S&P GSCI uses a front-month roll, whereas the S&P GSCI Dynamic Roll index use a systematic methodology to search for the contract months with the largest roll yield for each commodity to roll into (using only the most liquid of all available contracts of a given commodity).

When the futures curve for a given commodity is in contango, the S&P GSCI Dynamic Roll methodology will generally use futures contracts months that are further out on the futures curve, with the intention of minimizing the effects of negative roll yields.

When the futures curve for a given commodity is in backwardation, the S&P GSCI Dynamic Roll methodology will use nearby futures contracts. Commodity indices are constructed using liquidity and production figures. Given the economic importance of energy in general and oil in particular this leads to a heavy energy-weight.

To avoid this energy-tilt the Bloomberg Commodity Index restricts weights of individual commodities and related commodity groups. This results in a much lower energy weight in the Bloomberg Commodity Index (one third) compared to S&P GSCI Index (two thirds).

Given the strong energy performance it comes as no surprise that GSG and COMT are performing strongly.

ETFs linked to the Bloomberg Commodity Index like the iShares Bloomberg Roll Select Commodity Strategy ( CMDY ) and the Aberdeen Bloomberg All Commodity Longer Dated Strategy ( BCD ) are lagging.

USCI is designed to outperform GSG when the markets are in contango and when energy is underperforming. The opposite is happening and nevertheless USCI is outperforming. We can only repeat that USCI remains our favorite commodity ETF .

COMT can be a nice combination of USCI’s roll optimization and GSG’s energy “heaviness”. It’s currently certainly the only commodity ETF in a long term uptrend.

Energy is likewise the only commodity sector in a long term uptrend and this favors the more energy-heavy COMT.

Conclusion

Due to their inflation hedging qualities and diversification benefits commodities should remain part of your portfolio. Should we favor a traditional front-month ETF like GSG or an optimized ETF like USCI or COMT? Optimized commodity ETFs have better long term returns, outperform especially when commodity markets crash (and move to contango) and they obtain these results with lower volatility.

We repeat that USCI remains our favorite commodity ETF. But the current environment, with Energy being the only commodity sector in a long term uptrend, favors also an investment in the more energy-heavy COMT.

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